Community-Based Approaches in Philippine Agricultural Projects:

Fad, Facts, and Framework

FINAL REPORT*

Roehlano M. Briones
Postdoctoral Fellow (Economics)
WorldFish Center
Jln. Batu Maung, Batu Maung
11960 Bayan Lepas
Penang, Malaysia

Submitted to the Philippine Institute for Development Studies

, 2003

*
The comments of Cristina David are gratefully acknowledged. The author alone is responsible for the
contents of this paper.
1. Introduction

Community-based approaches (CBAs) are now widely accepted as an essential element

of development at the grassroots. Development discussions are often fashionably laced
with the rhetoric of “participation” and “empowerment”. Such rhetoric however risks
obscuring a critical assessment of what makes CBAs work, or even whether they work as
well as believed. This paper contributes to such an assessment by surveying the literature
on CBAs in agricultural development. Its main problem is to identify, at least
conceptually, the contribution of CBAs to the efficient implementation of development
interventions. This survey consolidates the various models of community-based
participation and organization into a coherent framework. Some of the evidence for these
models are also reviewed.

The analysis will form the basis of drawing broad implications for public policy. This
study adopts an economic approach, which is most appropriate for the analysis of
efficiency. Even measures aimed at equity and sustainability – two other major aims of
development policy – need to be evaluated in terms of cost-effectiveness relative to
alternative measures of equity and sustainability. Part of the efficiency analysis of this
paper is to delineate the roles between public and private sector, to avoid wastage of
public funds in activities that can be done as well or better by the private sector.

The economic approach is of course only one of several viewpoints by which to evaluate
CBAs. Where appropriate perspectives from other social sciences (e.g. anthropology and
sociology) would be taken into account. In terms of normative analysis, the other social
sciences would posit objectives other than efficiency; Michener (1998) for example
idealizes the “transformative” attitude towards beneficiary participation (i.e. participation
as seen as an end in itself, rather than a means to an end). This paper takes an
instrumentalist attitude, not because it is normatively “better,” but only to maintain
analytical focus.

In terms of positive analysis, economics emphasizes methodological individualism.

Social phenomena are reduced to individuals and their interactions; individual motivation
is identified with rational self-interest, while group interactions result from different
individuals simultaneously trying to realize their own interests. This is formalized by the
mathematical construct of the utility function, which each individual attempts to
maximize subject to constraints; stable patterns of behavior across individuals are
described by an equilibrium in the system of interactions. Insistence on methodological
individualism is an analytical simplification; it should be recognized that such an
insistence may undervalue some important facets of organizations, such as the formation
of norms, power relations, and similar phenomena stressed by the other social sciences.
These factors shall be referred to occasionally throughout the paper.

Definitions of CBAs abound. For this paper the essential characterization of a CBA is
beneficiary participation, collectively organized at the community level, in designing and
implementing development interventions. This definition identifies three elements,
namely participation, collective action, and organization. This study will provide a

1
detailed treatment of the elements of participation, collective action, and organization.
The rest of the paper is organized as follows: CBAs in Philippine agriculture and policy
are discussed in Section 2. The basic argument behind beneficiary participation in
development projects is presented in Section 3. Section 4 deals with the problem of
collective action. Collective action in agribusiness functions (processing and trade)
require deeper analysis of organizations, which is most formally embodied in the
agricultural cooperative to be discussed in Section 5. Section 6 discusses the policy
implications. Section 7 concludes.

2. CBAs in Philippine Agriculture1

Community-based arrangements are not a new development in Philippine agriculture. In

irrigation for example, communities have evolved traditional systems in handling the
management of communal facilities. Attention has been drawn to the ingenious zangjera
in Ilocos Norte, a communal arrangement covering small brush dams spanning a few
villages. The zangjera exhibits features that have sustained collective efficiency in water
use, despite some inefficiency in intra-farm utilization (Cruz and Cruz, 1984).

The cooperative movement also began making inroads into the Philippines from the late
19th century. By 1952, support for cooperatives reached the legislative level in the
enactment of the Agricultural Credit and Cooperative Financing Administration Law.
The law organized cooperatives who were provided collateral-free loans, mostly in
restive areas in Central Luzon. Unfortunately the program was unsuccessful as 72% of
loans went unrepaid; numerous state-sponsored cooperatives folded up, often as a result
of incompetence and corruption (Sibal, n.d.).

The Martial Law Period

The thrust towards agricultural modernization gathered momentum in the Martial Law
period. With it came a renewed emphasis on community-based approaches. Considerable
investment was made in irrigation systems, which were initially characterized by a
command-and-control mechanism. Later the National Irrigation Administration (NIA)
began turning over fee collection and management to user associations. The NIA also
organized Irrigators Associations (IAs) to manage communal irrigation facilities (with a
coverage area of 1,000 ha. or smaller.) Based on its internal guidelines, at least 80% of
farmers in the coverage area should be members of the IA prior to the construction of a
facility. An IA is administered by its own board of representatives, elected by majority
vote of members. Ideally the IA should be involved in in all phases of a project (planning,
construction, and maintenance) as well as in shouldering project cost. In addition to an
engineer, who oversees the technical side of irrigation works, the NIA provides an
Irrigation Development Officer who works full-time at community organizing, as well as
coordinating between farmers and technical staff.

1
This study distinguishes agriculture from the natural resource sector, in which CBAs figure even more
prominently. The latter though is outside the scope of the paper.

2
Measures were also instituted to further strengthen agricultural cooperatives, as well
farmer associations known as the Samahang Nayon (SN). The Samahang Nayon was
organized to facilitate land reform, and train farmers in cooperation and business
activities; after adequate preparation, these SNs were to be transformed into full-fledged
cooperatives with business functions. SNs and farmer cooperatives were given key roles
in the Masagana 99, a direct credit program for increasing yields and achieving
agricultural self-sufficiency.

The Post-Martial Law Period

The return of democracy ushered in a new Constitution, which mandates the promotion
non-governmental, community-based, and sectoral organizations as state policy. On this
basis, Congress enacted several laws that recognized CBAs in development. Foremost of
these is the RA 6838, or the Cooperative Code, and its companion RA 6839 which
formed the Cooperative Development Authority (CDA) under the Office of the President.

The Code defines cooperatives as follows (Section 3):

a duly registered association of persons, with a common bond of interest, who have voluntarily
joined together to achieve a lawful common social or economic end, making equitable
contributions to the capital required and accepting a fair share of the risks and benefits of the
undertaking in accordance with universally accepted cooperative principles.

These principles include (Section 4):

Democratic control. Members of primary cooperatives shall have equal voting rights on a
one-member-one-vote basis. Cooperatives shall be administered by persons who are
democratically appointed.

Limited Interest in Capital. Share capital shall receive a strictly limited rate of interest.

Division of Net Surplus. Net surplus arising out of the operations of a cooperative
belongs to its members and shall be equitably distributed for cooperative development
common services, indivisible reserve fund, and for limited interest on capital and/or
patronage refund in the manner .

Cooperative Education. All cooperatives shall make provision for the education of their
members, officers and employees and of the general public based on the principles of
cooperation.

Cooperatives are classified into the following types under the Cooperatives Code: Credit
cooperatives function as savings and loan associations. Consumers cooperatives
specialize in procurement and retailing of commodities, at least in part for the benefit of
members. Producers cooperatives are organized for agricultural or industrial production
and may run farms or factories. Marketing cooperatives engage in the supply of
production inputs and marketing services for members. Service cooperatives engage in
various household and community services, including health, insurance, housing,

3
transport, labor, electricity, and communication. Finally, multi-purpose cooperatives
combine two (2) or more of the business activities of various kinds of cooperatives.

Cooperatives, like corporations, are limited liability entities (Section 12). Unlike
corporations though, the Code explicitly exempts cooperatives from taxes on transactions
with members (Section 62). Other tax provisions include: Small and medium size
cooperatives (with net savings of below 10 million pesos) are exempted from all taxes,
including custom duties on imports of machinery (where said equipment is locally
unavailable). All new cooperatives (ten years or below) are exempted from income and
sales taxes.

Cooperatives are also accorded a number of privileges, including:

• The preferential right to supply government institutions and agencies with

agricultural commodities produced by their own members;

• Preferential treatment in the allocation of cargo in commercial shipping vessels;

• Preferential rights in the management of public markets and lease of public

market facilities;

• For credit cooperatives, entitlement to loans, credit liens, rediscounting, and other
eligible papers with government financial institutions;

• Exemption from pre-qualification bidding requirements in transactions with the

Philippine Government and its corporations.

In addition to the Cooperative Code, the other relevant landmark legislations are the
Comprehensive Agrarian Reform Law, the Local Government Code, the Magna Carta for
Small Farmers, and the Agriculture Fisheries Modernization Act (Castillo et. al., 2003).
Cooperatives are recognized as a crucial link in the government service delivery at the
local level. Funds from agricultural modernization are allocated to farmer organizations
and cooperatives. Cooperatives are provided special treatment in the promotion of
marketing activities (such as fertilizer distribution), and are the main conduit for the
conduct of livelihood projects.

In the area of agricultural credit support, the post-Martial Law period saw a shift away
from direct credit programs owing to low repayment rates afflicting these schemes. The
new generation of credit programs place more emphasis on group-based lending and
savings mobilization (Esguerra, 1995). Credit delivery was increasingly shifted to
government financial institutions. A major source of agricultural finance (particularly for
developing agrarian reform areas) is the Land Bank of the Philippines (LBP), which
courses its small farmer lending through cooperatives.

Despite all this legislative support, Castillo et. al. (2003) note that the current legal
framework differs from the previous ones in the relative absence of explicit funding

4
allocation support for cooperatives. Rather, under the principle of subsidiarity invoked by
the Cooperative Code, the cooperative sector itself is given the primary responsibility for
its own progress. Limited funding for agricultural development (in particular the meager
appropriation of the CDA) has ruled out the aggressive state promotion of cooperatives.

Nevertheless the cooperative sector remains sizable; around 2.8 million persons are
organized in nearly 60,000 cooperatives all over the country (Table 1). In Philippine
agriculture, the most common types of cooperatives have provide marketing and credit
services. Only 57% however are operating; the rest, while registered, are non-operating
or are effectively dissolved. Of the registered cooperatives, by far the greatest proportion
is found in agriculture, mostly in the form of multipurpose cooperatives. Multi-purpose
nonagricultural cooperatives are second, while credit cooperatives are a distant third.

Table 1. Selected statistics on cooperatives in the Philippines, 2001

% of total
Number of registered cooperatives 59,765 100.0
Total membership (As of December 31, 2000) 2,838,913 100.0
Paid-up share capital of cooperatives (pesos) 3,720,677,553
Number of cooperatives, by operational status
a. Operating Coops 33,989 56.9
b. Non- Operating Coops 21,479 35.9
c. Dissolved and cancelled 4,297 7.2
Number of cooperatives by type
Multi-Purpose (Agricultural) 33,012 55.2
Multi-Purpose (Non-Agricultural) 17,641 29.5
Credit 3,934 6.6
Service 1,425 2.4
Consumers 1,208 2.0
Producer 1,066 1.8
Marketing 767 1.3
Other cooperatives 712 1.2

SOURCE: CDA

3. Participation in Development: Basic arguments

Evidence on participation

While anecdotal accounts of the benefits of participation abound, solid evidence is only
recently accumulating. Alkire et. al. (2001) enumerates several cases in which
participatory/community-based approaches have promoted the efficiency and
effectiveness of rural development programs. These include:

5
 • A study of 1,875 households in rural communities in six countries (Benin,
Bolivia, Honduras, Indonesia, Pakistan, Uganda) suggests that water system
sustainability is greater when communities make key investment decisions and
when they pay part of the investment costs, as they can assert their preferences in
the asset design (Sara and Katz, 1997).

• A study for Bangladesh suggests that Parent Teacher Associations might be in the
best position to determine which children should receive tuition or school lunch
subsidies (Ravallion, 1999).

• Research on community-based irrigation systems in Asia usually find that systems

built and operated by users (often with little external assistance) are more
productive compared to government-built systems (Lam, 1998).

• Studies on education and communities in the Philippines (Jimenez and Paqueo,

1996; Jimenez and Sawada, 1998) find that community-managed primary schools
appear to supply similar levels of enrollment and quality with lower costs.
Community management may likewise lead to better educational outcomes.

• A case study of water supply projects in five Indian states finds that the most
successful projects were those in which decision-making authority was
decentralized in such matters as the location of water standpoints and latrines, and
where organizations to monitor and maintain these facilities were developed
(Manikutty, 1998).

In addition, Korten and Siy (1989) have found that participation motivates sustainability
and cost-recovery in irriagation systems. Ostrom, E. and R. Gardner (1998), citing
Svendson (1992) note that where farmers have been allowed to effectively organize,
greater diversity of rules have emerged from the annual bargaining process. Such
localized rule formation promotes efficiency of water use.

Admittedly, correlations between beneficiary participation and project success are prone
to selection bias, i.e. the factors accounting for project success may be the same factors
that make participation more likely. For example, in communities were average ability
and educational attainment is higher, development interventions are more likely to be
effective; simultaneously, individuals are more likely to welcome community action.
Some studies deal with this source of bias. Isham et. al. (1995) show that participation
has improved service delivery in water supply projects, and that causation runs from
participation to service, rather than the other way around. Grootaert (1999) as well as
Grootaert and Narayan (2000) relate generic community participation directly to
household outcomes by applying multivariate regression to cross-section data. With
measures of household welfare, assets, savings, and credit access as their dependent
variables, they include as determinants indicators of community involvement, such as
membership in a peasant organization. In Indonesia and Bolivia, greater community
participation leads to larger household assets, more savings, better credit access, and

6
higher per capita spending overall. The causation runs from participation to household
outcomes rather than the reverse.

Hodinott et. al. (2001) apply multivariate regression to link participation with the impact
of public works programs in South Africa. They found that participation leads to the
following: a lower ratio of project to local wages; increases in labor intensity; lower costs
of creating employment; and lower costs of transferring funds to the poor. To account for
the possibility that participation is also an effect of underlying success factors, the study
controls for selectivity bias. There is no evidence that community participation increases
cost overruns or the ratio of training to employment.

Rationale for participation

Hodinott et. al. (2001) also present a model that explains why participation should have
salutary effects documented in the foregoing. Three entities are posited, namely the
financier, the provider, and the community (i.e. the beneficiaries). In the traditional top-
down arrangement, these functions are sharply delimited; beneficiaries are passive
recipients of externally provided and funded services. This arrangement though may
encounter problems when the flow of benefits is sensitive to local conditions and is
dependent on information that only beneficiaries are likely to have. For example,
irrigation systems best designed when detailed information on water flows and soil
conditions are available. Engineers and external planners often lack such detailed and
site-specific knowledge.

Furthermore, when external monitoring is costly, financiers and providers may undertake
opportunistic behavior that reduces welfare impact on beneficiaries. For example,
providers may impose their own preferences for public prestige on the design and
implementation of the project; the financier can also distort project design towards their
own ends owing to their control of project funds. In other words, one of the parties can
“holdup” the entire project and the economic surplus it could generate by threatening
withdrawal.

Such problems can be addressed by permitting overlap of functions. In the model,

participation is interpreted as a form of role-sharing, in which the community also acts as
a provider and sometimes a financier. This arrangement is a more effective means of
tapping the information endowment of communities. Furthermore, it is more likely to
align project design and implementation towards a more efficient realization of
beneficiaries’ welfare.

The foregoing model is highly simplified, in that communities appear as monolithic

entities. They act as if they were a single agent, utilizing their information endowment, in
designing the project, and in monitoring or undertaking project operations. However
motivating and coordinating individual beneficiaries in a group endeavor is far from a
trivial matter. The problem of collective action, is discussed in the following section.

7
4. The problem of collective action

In the standard model of general equilibrium, marginal benefits and costs of economic
decisions are all internal. In this special case collective action is superfluous, i.e. the
competitive price system mediates all transactions needed to achieve allocative
efficiency. However there are numerous instances in which internalization of all marginal
benefits is infeasible. In the case of public goods, reliance on the price system leads to
undersupply, as beneficiaries would attempt to free ride on others’ contributions.

Collective action can occur at the state level; public good provision by the state is in fact
the standard assumption in the public finance literature. However, especially for local
public goods, provision by the state may not be the most appropriate. The whole idea
behind CBAs is the superiority of community level cooperation over state level collective
action. To explain community level cooperation, game theoretic models of strategic
interaction between individuals becomes a relevant analytical framework.

Game theoretic analysis

In game theory, individuals are “players” who select one out of a set of possible
strategies, with each combination of individual strategies yielding a set of individual pay-
offs. A cooperative solution, which corresponds to collective action, is that combination
of strategies that yield the largest group pay-off. The modeling thrust therefore is to
ascertain whether a cooperative solution is an equilibrium.

The “Prisoner’s Dilemma” describes a non-cooperative equilibrium. The dilemma arises

when a player who does not cooperate, or defects, can realize a pay-off larger than that
under cooperation, as long as other players do not defect. However if other players
defect, the maximal group pay-off is forfeited. The Prisoner’s Dilemma is a common way
to describe the breakdown of cooperation.

The standard answer to this dilemma is the folk theorem (Fudenberg and Maskin, 1986).
According to this theorem, cooperative solutions are equilibria for games that are
repeatedly played, as long as the following conditions are satisfied: players who defect
can be identified and penalized; defection is not too rewarding; and the future is
sufficiently important to each player. The basic idea is that players who permanently
cooperate obtain a net gain from a continued relationship with other players; this imposes
an opportunity cost on defection.

It is noteworthy though that in games that seem to closely approximate real world
situations, a cooperative solution is just one of many equilibrium outcomes. A
noncooperative solution may be an equilibrium as well; other factors must be introduced
into the game structure to sharpen the model’s predictions. Exogenous factors such as
group norms and group trust may tilt equilibrium towards cooperation. Norms lay down a
set of expectations regarding individual behavior shared by group members. Trust
provides assurance that other players will cooperate in a predictable manner, subject to
past known behavior. The stock of trust specific to a network of cultivated relationships

8
has been referred to as “social capital” and may be crucial to the solution of the collective
action problem.

Aggarwal (2000) presents a model that captures the importance of group norms. Consider
a group of N farmers, e an N-dimensional vector of inputs from by the farmers (which
can include effort). The cost to each farmer is given by C (ei ) , while the benefit accrues
to the group and is given by f (e) ; suppose each individual receives an equal share in this
group benefit. Then the individual’s maximization problem is given by

f (e)
max − C (ei ) for individual i, i = 1, 2, …, N (1)
N

On the other hand, the Pareto optimum (which maximizes group net benefit) is obtained
from the solution of a different problem:

max f (e) − ∑ i =1 C (ei ) .

N
(2)

Clearly the solution to (2) diverges from the solution to (1); it is easy to show that the
solution to (1) implies underprovision of effort relative to the solution of (2).2 To avoid
such a solution, one may conceive of a “peer pressure function” Pi specific to individual
i. This function is also dependent on the effort levels of the members. Hence (2) is
modified as

f (e)
max − C (ei ) − Pi (e) for i = 1, 2, …, N (2’)
N

Each member must take into account not just the benefits of free-riding, but also the
sanctions of peer pressure in deciding upon individual effort level. The higher the extent
of peer pressure, the smaller the difference between actual contributions and the group
norm. Based on the foregoing, Aggarwal identifies several factors contributing to the
likelihood of group cooperation, such as: a smaller group size, kinship ties among
members, interaction between members in a variety of social settings, a history of past
cooperation among members, availability of information about benefits and costs of
collective activity, and high group regard for norms.

Evidence on collective action

In addition to group norms, Molinas (1998) cites other factors as relevant for collective
action, namely: gender, outside intervention, and heterogeneity of players. With respect
to gender, cooperation is usually deemed more likely the more actively women
participate in group. Outside agents meanwhile are expected to promote cooperation if

2
The first order conditions for (1) and (2) respectively are: f i ' (e1 ) = NC '(ei1 ) ; f i ' (e 2 ) = C '(ei2 ) . Then
e1 < e 2 if C " > 0, f " < 0 .

9
they provide training and education in cooperation, as well as assist in identifying and
penalizing defectors. On the other hand, they may impede cooperation by exacerbating
internal conflict, or create dependency relations that undermine organizational autonomy.

As for heterogeneity, the literature contains mixed expectations. In the first place, too
much homogeneity may inhibit the rise of “organizational entrepreneurs” who would
invest time and effort in forming a functioning group; on the other hand, homogeneity
may improve awareness about mutual dependency, a factor identified by Ostrom and
Gardner (1993) as an element of successful local cooperation.

Molinas’ empirical analysis uses data from 104 peasant organizations in Paraguay. He
constructs an index measure of organizational performance based on: conduct of poverty
reducing activities (i.e. joint commercialization, rotating loan funds, local public good
provision); attendance of members; leaders’ evaluation; members’ satisfaction; and the
degree to which organizational experience was emulated. He related this index to proxy
measures of collective action determinants, namely:

gender – an index of degree of women’s involvement in the organization

outside help – measured by the number of training courses conducted by higher level
peasant organizations and undergone by lower level organizations
social capital – an aggregated subjective index of frequency of informal interaction
relative size – measured by the fraction of member households in total households of a
community
age of the organization
initiative – a dummy variable for whether an organization is a community initiative
tenure – measure of the stability of leadership, i.e. number of years of tenure of current
group of officials
welfare – proxy of well-being of the community, uses the median size of landholding
adjusted by the average land price within a community
heterogeneity - measured by the Gini ratio of landholding at the community level

He finds that the significant monotonic determinants of collective performance are: social
capital, gender, and community welfare. Only the last has a negative sign, i.e.
organizations from poorer communities tend to be more successful. Meanwhile, outside
help appears to be in an inverted-U relationship to collective performance. That is, at an
initial range these factors promote collective performance, but eventually a saturation
point is reached, from which further increases in outside help adversely affect collective
performance. Interestingly, Molinas finds that heterogeneity (proxied by the Gini ratio of
landholding) is also in an inverse-U relation to collective performance.

The foregoing discusses the collective action problem in general. The ensuing discussion
sets the problem in the context of two major areas of collective action in agriculture, that
of irrigation and credit delivery.

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Collective action in communal irrigation

The problem associated with managing and maintaining an irrigation system is well-
known; water delivery is too costly to meter and price individually, hence some collective
mechanism must be enforced to prevent excess consumption by some users (especially
those upstream) as well as to maintain the facility (to reverse the effects of normal wear,
to prevent weed growth, to repair dams and canals in the event of flood, etc.) Monitoring
and maintenance generates group benefits, opening up opportunities for free riding
among members.

In many developing countries, centralized administration has given way to management

by user associations. A prominent example of successful cooperation between parastatal
and user associations is that of Taiwan; Lam (1996) attributes this to the parastatal’s
decision to set up working stations to act as intermediaries with the user associations. In
practice, the working stations acted as the de facto authority at the field, allowing timely
decisions to be taken in response to contingencies. Delegation to the working station
entails softening hierarchy lines, hence the field staff were compelled to develop good
will relations with the user associations in order to maintain a high performance level.

Experience in other countries, especially in Southeast Asia, has been far more uneven.
Reliable empirical regularities relating success or failure are hard to identify. For
Philippine irrigation, the most extensive empirical study has been conducted by Fujita et.
al. (2001). Their study focuses on 46 IAs in national irrigation systems found in Region
4. First they measure cooperation using a composite index obtained by principal
components analysis. The index incorporates the following:

• collective work for cleaning canals and laterals;

• coordination in rice cropping schedules;
• practice of water rotation; and
• organized monitoring on cropping schedule and/or water rotation.

They then run a regression analysis to identify factors significantly associated with
cooperation. It is found that collective action is difficult to organize where:

• water supply is uniformly abundant;

• water supply is greatly different between upper and lower streams in lateral
• size of association is large
• population density is low
• the ratio of non-farm households is high;
• farmers have a background of rainfed farming and little history of irrigated
farming

These findings are consistent with the institutional economics of collective action,
namely, that collective action is easiest in: small groups; where benefits from
organization is high; where density of interaction is high; where exit options are
constrained; and where social capital has been built up by community experience.

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Collective action in credit delivery

Another area in which group cooperation shows promise is in credit. The benefits of
group action can be explained in relation to the market failures that prevent efficient
credit delivery. A credit transaction hinges on a commitment made by a borrower; the
quality of this commitment is subject to uncertainty owing to weak enforcement and
asymmetric information. Repayment problems fall under two major categories, namely
moral hazard and adverse selection.

Moral hazard arises when ex post a borrower opts to default, or neglects to ensure the
profitability of the funded project. Adverse selection meanwhile refers to the increase in
average risk in the pool of potential borrowers as interest rates rise to take into account
the average default risk. Under heterogeneity of default risk, charging the average default
risk may lead to the exit of low risk borrowers and therefore higher average default risk
(the “lemons” problem). At the extreme, interest rates may escalate to levels that leave
only sure defaulters inside the market. This eliminates the credit market entirely.

Institutional adaptations and practices have evolved in response to these problems.

Lenders can screen their borrowers in advance, monitor their borrowers’ behavior, and
verify default claims. They can ration credit by limiting loan sizes. Dynamic incentives
can be offered by allowing loan sizes to expand over time, while threatening to cut off a
credit line in the event of a default. In the formal sector, a common practice is to require
collateral.

Joint liability lending, which introduces the collective element in finance, is another
means to deal with the moral hazard and adverse selection problem, Consider a bank that
lends to the rural poor. Instead of lending to individuals, they may lend to a group, which
then channels the funds to the members. The group as a unit assumes responsibility for
repaying the entire loan. The arrangement clearly shifts transaction costs from the lender
to the group members. There is however good reason to suppose that total transaction
cost may fall3 as the joint liability arrangement provides and incentive for members to
exercise peer monitoring. Typically, group members reside in the same community,
hence information concerning individual risk type and economic behavior is readily
available. Moreover, peer disapproval can be a strong deterrent against naked
opportunism. Joint liability with contract enforceability at the peer level solves the moral
hazard problem (Stiglitz, 1990).

Recent models have tried to explain how group lending addresses not just moral hazard,
but also adverse selection. Unlike peer monitoring models, in which organized groups are
given, adverse selection models are able to account for group formation. Moreover, the
peer selection model is simpler than that of peer monitoring, as the joint liability scheme
need not require a technology for monitoring and enforcing contracts at the intragroup
level. Ghatak (2000), considers the following set-up: suppose there are two risk types

3
“Economies of scale in lending” is often cited as a reason for organizing borrowers into groups; however,
as lending must still occur within a group, ultimately scale economies must be attributed to better loan
processing and monitoring technologies within a group.

12
(safe and risky), and borrowers know each other’s risk types though this is unknown to
the lender. Peer group formation involves, at equilibrium, a sorting of groups (of pairs or
partners) into those composed of only safe borrowers, and those composed of only risky
borrowers. Ghatak shows that, compared to the without-group scenario, group formation
can induce safe borrowers to re-enter.

De Aghion and Gollier (2000) offer an even more general model in which borrowers
need not be aware of each others’ risk types. Suppose there are only two types of project
– a safe one, with zero probability of zero returns, and a risky one, with positive
probability p of zero returns (loss) and a probability of 1 - p of a fixed yield. However,
confirming that indeed a loss has occurred requires a positive verification cost. Each
borrower borrows a fixed amount for one type of project. Suppose banks insist that loans
only be extended to pairs, each pair being jointly liable for a loan. This arrangement deals
with the adverse selection problem in two ways: First, it decreases verification cost, as
loss claims are transferred from individuals to pairs; second, joint liability implies an ex
post subsidy from a safe to a risky project in the event of loss, hence functions as ex ante
collateral. Interest rate increases can therefore be moderated (as long as returns from safe
projects are not large enough to repay the loss of a risky project).

Joint liability lending is a scheme to channel funds from external sources. Meanwhile
savings and loan associations (e.g. credit unions and cooperatives) provide intermediation
services for funds internal to the community. Of course, membership in such associations
must be sizable, curtailing reliance on small group lending (unless such a strategy is itself
adopted by the association). Barham and Boucher (1996) have pointed out that for such
savings and loan associations, the incentive for net depositors to monitor net borrowers is
even stronger than in the case of pure external finance. Moreover, the obligation to repay
is reinforced by the imperative to maintain a pool of funds which all association members
find valuable for its insurance-like protection.

The microfinance movement, fueled by popular accounts of successful microcredit

schemes, is currently sweeping poverty alleviation programs worldwide. The movement
was pioneered by the Grameen Bank in Bangladesh, which introduced very small loan
sizes, joint liability lending, frequent collection, mandatory savings, preference for
female borrowers, and values training. Repayment rates are reportedly much higher,
while cost recovery more feasible, compared to traditional direct credit systems.

However, evidence for or against group-based lending is far from clear-cut. Huppi and
Feder (1990) examined the performance of such schemes and identified several factors
that seem correlated to repayment rates, namely: small group size; homogeneity of the
borrowing groups; previous experience in borrowing; and finally, specialization of the
group in credit (i.e. the group itself was not engaged in other joint commercial activities,
as is common in multipurpose agricultural cooperatives). Interestingly, for the Philippines
(as well as India) the cost of borrowing was not lower for group-based lending, contrary
to the trend in other developing countries.

13
The finding on group size is echoed by Ghatak and Guinnane (1999). They note that in
the Grameen program, the group size is typically set at five, a figure that was reached by
trial and error. On the negative side, experiences in Nepal have shown that mutual trust is
meager in larger groups (20 or more). Moreover, the origin of the group matters; groups
formed by program officials tend fall under the delinquent category.

Morduch (1999) cites a survey of 72 microfinance programs worldwide with professed

commitment to financial sustainability; contrary to impression, financial performance of
programs lending to individuals are similar to those lending to solidarity groups. This
finding certainly questions the necessity of group-based lending, though of course does
not detract from its value in numerous settings.

Morduch’s survey also found some interesting facts about sustainability. The covered
programs are generally characterized as operationally sustainable (with a few
exceptions). However, incorporating the opportunity cost of capital, the programs
typically remain subsidized (by around 17% on average). Moreover, the subsidy tends to
be equally dispersed across beneficiaries and not concentrated upon the poorest clients.
The limited bias towards the poorest is similarly found in Guatemalan credit unions,
which have provided measurable relief from binding credit constraints. However, the
poorest individuals typically did not benefit from increased access to credit (Barham and
Boucher, 1996).

Morduch also finds that estimates of net welfare impacts are scanty. In general his review
finds that empirical regularities regarding group-based lending (in terms of success
factors and impacts) have yet to be developed. Much of the evidence offered remains
anecdotal. Likewise, Ghatak and Guinnane (1999) concede that joint liability lending is
correlated with improved repayment, but most successful programs have other features
that could account for this correlation. No study apportions reasons for success. Needless
to say, research isolating these contributory factors would be of great interest and value to
policy.

Aside from credit support to agriculture, CBAs have been recommended for other
agribusiness activities such as processing and trade. Collective action in these areas is
closely associated with the most formal and commercialized form of community
organization, which is the cooperative. This form is treated in the next section.

5. The cooperative as a community-based approach to agribusiness organization

The fundamental difference between the cooperative and the standard firm is the
ownership structure (Sykuta and Cook, 2001): while the former may be regarded as a
patron-owned firm (POF), the latter may be referred to as an investor-owned firm (IOF).
In the IOF, decisions are made by investors, towards the joint maximization of the
residual claim. As a background to the POF, the discussion will deal with the IOF
structure in some detail.

14
Theory of the Investor-Owned Firm

In the elementary theory of the IOF, the firm appears as a monolithic entity with the sole
objective of maximizing profit. Accordingly, input and output choice is determined at the
equality of marginal revenue and marginal cost; competitive equilibrium implies equality
of price and marginal cost. Allocation can be inferred solely from the production function
and prices; the only function of ownership structure is to inform the distribution of the
surplus.

Early models of the IOF pinpointed the locus of monolithic choice in the abstract owner-
proprietor, or entrepreneur. In a seminal paper, Coase (1937) identified transaction coast
as the key consideration in identifies the boundaries of the firm (i.e. which activities to
undertake internally, and which to be purchased as input or service from the market).
However, inasmuch as the allocative function can itself be discharged by a manager hired
from the labor market, it was not clear why control needed to be associated with residual
claim or asset ownership. Models which recognize the fact that IOF is really a set
contracts between individuals (rather than a monolithic maximizing entity) are needed to
understand its ownership structure.

Alchian and Demsetz (1972) used team theory to arrive at an agency explanation for the
residual claim. Consider a production team whose technology is subject to economies of
scale and scope. This makes the marginal product of each team member’s effort difficult
to measure; hence, each member has the incentive to shirk. Suppose though that one team
member can specialize in metering marginal product, thus aligning effort with rewards.
This monitoring task itself is vulnerable to shirking on the part of the monitor; to remedy
this, the monitor may have to be paid a residual claim. The residual claim meanwhile is
more credible if supported by actual control over decision-making; in a private property
system, the owner is given the right to decide whom to give access to a resource. This
confers decision-making powers on the asset owners. Hence when asset ownership is
held by the residual claimant, who is also responsible for monitoring, then all incentives
are properly aligned to address the inefficiency of free riding.

In practice, while the ultimate monitors are the firm’s owners, daily monitoring tasks
must be delegated to managers, which adds another layer to the principal-agent relation.
This management layer commands the most attention, particularly in the corporate
governance literature. A common theme is that the equities market itself is device to
ensure productive use of an IOF’s assets, by ensuring flexibility of ownership, and
providing a means to value the firm. Shareholders incapable of proper selection and
monitoring of managers can be bought out; at the extreme, management can be revamped
as a consequence of a “hostile takeover” (Shliefer and Vishney, 1996).

Free riding behavior is not the only problem dealt with by investor ownership. Another
form of opportunistic behavior is the “holdup” problem, which arises under conditions of
asset specificity (Klein et. al., 1978). In many production processes, assets become
specific to a combination or pool if the value of the pool exceeds the sum of individual
asset values. Under divided ownership, any party can bargain for a greater share in the

15
surplus on the threat of withdrawal from the combination. Transaction cost theory
predicts that when holdup is a serious problem, assets will tend to fall under common
ownership (Williamson, 1985).

Early models of the Patron-Owned Firm

Early models of the POF parallel those of the IOF in adopting a monolith assumption.
these models, the major preoccupation was to identify the objectives of the cooperative,
as well as allocative implications of each objective (e.g. Coterill, 1987). Statements of the
objective are stated in terms of maximizing one of the following:

• Producer surplus;
• Patronage refund, or consumer surplus (Helmberger and Hoose, 1962).
• Combination of producer surplus and patronage refund (Enke, 1945)
• Dividend (Ward, 1958).

Allocative outcomes are easily determined from these objectives. Maximization of

producer surplus entails the standard MR = MC condition; maximization of consumer
surplus (subject to a break-even constraint) implies equality of price with average cost;
and maximization of producer and consumer surplus entails the P = MC outcome.

Meanwhile if the maximand is the dividend, some algebra is required to work out the
implications: let the production function therefore be Q ( M ) , where Q is output and M is
the only variable input, measured by the number of members . Let Q increase with M at a
decreasing rate. Suppose output price is fixed at P, and the wage w is fixed at w. There is
a positive fixed cost F. The profit-maximizing firm would therefore set value of marginal
product equal to wage. In contrast, the dividend maximizing firm would select M so as to
equalize the value of marginal product with the average revenue (net of fixed cost):
P ⋅ Q '( M ) = ( P ⋅ Q − F ) M . Interestingly, strict concavity of the production function
implies a supply curve that is downward sloping.4 This conjecture, while interesting,
remains largely unsubstantiated by evidence (Bonin et. al., 1993).

As these models posit potential departures from profit maximization, they tend to suggest
that cooperatives perform no better than and may even be worse than IOFs in terms of
efficiency. However, studies on the technology and performance of cooperatives fail to
produce evidence for this view (Sexton and Iskow, 1993). Hind (1994) also compares
agricultural cooperatives in UK with IOF in agribusiness: on the basis of profitability,
capital gearing, liquidity, sales/working capital ratios, and creditor ratios, there were no
significant differences between the two type of firms.

Cooperatives and market structure

4
Total differentiation yields (dM dP ) ⋅ P ⋅ Q "( M ) ⋅ M + ( Q '( M ) ⋅ M − Q ) = 0 . Since the term in parenthesis is
negative, then dM dP must also be negative.

16
The implications of the various cooperative objectives are sharpened by examining the
implications of market structure. Under short run perfect competition, profit
maximization is equivalent to maximizing the sum of producer and consumer surplus;
however consumer surplus maximization implies inefficient oversupply of the output,
whereas dividend maximization entails undersupply. Under long run perfect competition
though, all four objectives enumerated above lead to the efficient equilibrium at which
price equals long run average cost.

It is in the case of imperfect competition that the contribution of the cooperative to

efficiency can be clearly noted (Normark, 1996). In the case of a monopoly, a
cooperative pursuing total surplus maximization would clearly be more efficient than a
profit-maximizing IOF. Cooperatives in direct competion with at least one large IOF
generates an mixed oligopoly or oligopsony, a setting which greatly complicates the
analysis. Sexton and Sexton (1987) examine the effect of potential entry of a supplier
cooperative on a market; they find that the effect differs markedly from that of potential
entry by an IOF. Potential cooperatives therefore exert a powerful role in beneficially
regulating free market performance. Tennbakk (1995) shows that total welfare is higher
in a mixed duopoly with involving cooperative compared to a pure duopoly consisting
only of IOFs.

An implication of the imperfect competition argument is that, in the long run, erosion of
imperfect competition would render cooperatives superfluous for efficient resource
allocation. However, even in developed economies, instances of imperfect competition in
agricultural markets abound. In the US market, food processing and marketing has in fact
exhibited a sharp trend towards consolidation (Sexton, 2000). In many agricultural
markets, raw products are costly to transport, and processors are sparsely distributed. The
persistence of market power would then support the long term contribution the
cooperative to agricultural efficiency.

Cooperatives and the new institutional economics

So far the foregoing models all apply the monolithic assumption in analyzing
cooperatives. The “new institutional economics” enriches the analysis by examining the
contractual arrangements among the individuals comprising the cooperative. The
“incomplete contracts” approach of Hart and Moore (1990) contains an in-depth
theoretical analysis of the IOF, which they extend to the case of the POF. As in the
transaction cost model, asset specificity is posited; in addition, they allow for investments
that can further increase the surplus from an asset combination, although such prior
investments are by assumption noncontractible (e.g. human capital investments). The
structure of ownership affects the incentive to provide these investments; the theory
predicts that the observed ownership structure would conform to the optimal incentive
design. The solution concept for ex post bargaining over surplus (“division of spoils”) is
the Shapely value.5 The ex ante investment decisions are determined as a Nash
equilibrium of investment strategies.

5
This solution concept roughly corresponds to the average of the marginal contribution of each agent to the
value of the asset combination.

17
The case of the POF can be explained as follows: Consider one asset, a set of S
individuals, and actions or investments taken by each individual to increase total benefits
available to the entire set. (Assume that no action yields any benefit without the asset).
We can form subsets or groups from S; suppose there exists a subset G such that
combinations containing less than or equal to half of the members of G generate no
marginal benefits from investing over all individuals. Then G constitutes a key group.
Their theory predicts that such a key group would own the asset. Hence, in the case of a
supplier cooperative, a key group would consist of the customers; in the case of a
marketing cooperative, a key group would consist of the suppliers.

The model however does not precisely identify instances in which a group of customers
or suppliers might emerge as a key group. Moreover it is not easy to find examples of
noncontractible prior investments for agricultural cooperatives, undermining the
relevance of the Hart and Moore model.

Sykuta and Cook (2001) posit the holdup problem as an explanation for the processing
cooperative. They point out that, once agricultural output has been delivered, the division
of the surplus from postharvest processing and marketing transforms into a zero sum
game. The prospect of holdup introduces ex ante distrust between contracting parties.
Vertical integration, with production and processing under common ownership, may
solve the holdup problem. However, vertical integration may not be feasible due to
diseconomies of scale in production, which may spill over into diseconomies of scope.
An alternative structure would be the processing cooperative, in which small independent
producers jointly own a downstream processor.

Decision-making by majority vote in cooperatives is examined by Albaek and Schultz

(1997) as well as Hendrikse (1998). The former discusses, in the context of agricultural
cooperatives, whether majority voting is inferior to voting rules which favor large
farmers (i.e. “one cow, one vote”. ) In a variety of cases the inferiority of majority voting
is cannot clearly be demonstrated; indeed in the case of a large cooperative which
finances investment out of retained earnings, the majority rule yields efficient decisions.
The latter paper by Hendrikse meanwhile focuses on the transaction cost of the decision-
making process in a cooperative. His model identifies a tradeoff between higher
transaction cost of cooperative and better “quality” of decision-making.

More novel approaches to account for the cooperative is that nonlinear pricing and
signaling. Vercammen, Fulton, and Hyde (1996) posit a purchasing cooperative as a
means to practice nonlinear pricing through a scheme of membership fees and rebates.
The efficient pricing rule, which is constrained by asymmetric information and
membership heterogeneity, entails a higher average price for higher delivery volumes.
The pricing rule can be modified to reflect equitable distribution of benefits across
members.

Another price discrimination scheme is found in Hart and Moore (1998). The supplier
cooperative is modeled as a mechanism for charging different prices for insiders

18
(members) and outsiders (nonmembers). Consider a group with M members, attempting
to provide each with one unit of a good. Fixed cost of provision is F > 0, but marginal
cost of provision is zero. The good can be purchased outside the group at a competitive
price p* ; by assumption, F M < p* , i.e. the average cost price is below the competitive
price (the group earns some rent). Members pay a nonnegative transaction cost for
purchasing this good from outside.

Members value the good heterogeneously, and this valuation is private knowledge. An
IOF which acts as a supplier must choose between a competitive strategy and a
monopolistic strategy. The former entails setting a price p* for all consumers, while the
latter involves selling only to insiders at a price higher than p* , which is possible when
transaction cost is strictly positive. The monopolistic strategy is inefficient due to the
excessive exclusion of consumers.

Alternatively the producer can be organized as a supplier cooperative, which is stylized

as a nonprofit entity adhering to the break-even condition. Then price charged to
outsiders and insiders can be differentiated. Insiders are charged the average cost price,
while excess capacity can be eliminated by sales to outsiders at the competitive price.
Due to the low inside price, the POF ‘s inefficiency results from excessive inclusion of
consumers.

On the balance it is not clear whether inefficient exclusion (a possibility for the IOF) is a
greater distortion than inefficient exclusion (a certainty for the POF). Two factors would
favor the superiority of the POF: first is a greater departure from perfect competition;
second is a greater similarity in members’ benefits, i.e. a more homogenous membership
profile.

Meanwhile the signaling explanation is taken up by Albaek and Schultz (1998). Consider
a farmers' dairy cooperative that competes against a profit-maximizing firm. The
cooperative maximizes the total profit of itself and its suppliers. Members of the
cooperative individually decide how much to supply; this turns out to be a commitment
device for credibly gaining a large market share. This device can enable it to realize
higher profit per farmer than would the profit maximizing firm.

Signaling could also explain adherence to a nonprofit status. Glaeser and Schliefer (2000)
present a model of the nonprofit firm, whose activities have an important quality
dimension that are essentially unobserved. A for-profit status is a signal that the firm
faces high-powered incentives for quantity provision, and relatively weaker incentives for
quality provision. A nonprofit status implies low-power incentives for quantity provision,
thus signaling better quality provision. Hence, a nonprofit firm may gain a competitive
advantage when customers, employees, financiers, or donors feel protected by its
nonprofit status.

This explanation could also account for the emphasis on members’ education in much of
the cooperative literature. Suppose donors or government seeks to finance quality training
of farmers in entrepreneurship, cooperation, community action, and civic consciousness.

19
Then nonprofit cooperatives may be more reliable suppliers of high quality training,
compared to for-profit entities such as agribusiness firms, and therefore command higher
amounts of financing.

6. Policy Implications

The arguments in favor of CBAs developed over the last three section seem to support a
policies for supporting and even subsidizing CBAs. There are however also good reasons
for exercising caution in extending such subsidies, mainly due to governance breakdown,
cooperation breakdown, and participation breakdown, to which CBAs are often prone.

Governance breakdown

While the cooperative can resolve some organization problems (as described in Section
5), it faces drawbacks of its own. Cook (1995) suggests the headings of portfolio, control,
and influence cost as categories of these problems. The portfolio problem arises when a
cooperative’s selection of assets is inconsistent with the interests or risk attitudes of any
given member; unlike for an IOF, the investor cannot easily withdraw her individual
share of the asset pool of the cooperative. Meanwhile the control problem is a general
difficulty inherent in agency relations, manifesting itself most sharply in the monitoring
of managers; for cooperatives however the control problem is exacerbated by the absence
of external pressure applied by the equities market. Finally, influence costs arise when
members or member coalitions expend effort and resources to sway organizational
decisions towards their own interest, possibly to the detriment of other members.

The Hart and Moore (1998) paper also analyzes governance problems associated with
majority rule in a cooperative. As usual this rule faces a median voter problem. For the
price discriminating cooperative, consider the following: two types goods can be sold,
conditional on investment outlay; the quality of the alternatives as well as the investment
requirements differ.

[S]uppose that, whatever the investment decision, a majority of members have small payoff (net of
cost), but they are slightly better off if the investment does not go ahead. And suppose the
minority consists of members who stand to gain a great deal if the investment does go ahead. In
such circumstances, the efficient decision is clearly to invest, but this will be blocked by the
majority. Moreover, any attempt by the minority to bribe the majority into changing their minds is
thwarted by free-riding on the part of individual members of the minority: the asymmetry of
information (combined with large numbers) means that no individual can be forced to contribute
to the bribe (p. 8).

Banerjee (2001) argues for the rent-seeking model of the cooperative, in which influence
cost is a dominant factor in cooperative decisions. Within cooperatives, the elite minority
group typically has an edge in mobilizing collective action, as it faces smaller transaction
cost and a less serious free rider problem. This model is applied ot the case of sugar
cooperatives in Maharashtra in 1971-1993. The elite is extracts rent by depressing the
purchase price and diverting the retained earnings of the cooperative. The study confirms

20
the prediction that in areas characterized by heterogenous asset holdings (as proxied by
land size), prices would tend to be lower and processing capacity more limited.

Cooperation breakdown

Cooperation between community members can break down for a variety of reasons. In
the area of credit, for instance, joint liability lending may simply shift part of the moral
hazard problem onto co-borrowers; opportunistic members may free-ride on the group’s
access to credit while reneging on their obligations. Close community ties could work
against efficiency as opportunists bank on peer leniency. Corrupt or weak group leaders
can divert funds, or coddle irresponsible members. Third, the community-based finance
would tend have a highly concentrated loan portfolio due to similarities in economic
activities of the members. This would therefore limit risk diversification, render portfolio
returns vulnerable to covariate shock, and invite liquidity problems as cash inflows and
outflows of members tend to be synchronized (Huppi and Feder, 1993). In the Philippine
experience, cooperative repayment performance has been far from exemplary. The LBP
for one faces a mounting challenge to maintain financial soundness while sustaining its
cooperative finance thrust, due to the repayment problems encountered in the latter
(Briones, 2001).

On a positive note, state support can make a difference in preventing cooperative

breakdown. In irrigation for instance, the Fujita et. al. (2001) study includes two policy
variables in the regression. The first is the provision of special incentives by the local
NIA; the second is the presence of dedicated and proficient local NIA staff. The
incentives take the form of subsidies and resource sharing in maintenance activity. To
detect the presence of excellent local staff, the interview method relied on a unanimous
identification by IA leaders and farmers (agreement was observed for around 15% of the
respondent IAs). These policy variables are found to be statistically significant factors for
promoting cooperation.

Participation breakdown

Empirical and theoretical analysis of participation presupposes that instances of

participation can be identified. This turns out to be a nontrivial exercise; considerable
anthropological and sociological analysis has gone into verifying the authenticity of
claimed participatory processes (Castillo, 1978).

A critical source of participation breakdown is the maneuverings of the local elite.

Abraham and Platteu (forthcoming) enumerate various reasons for frustration of
participatory processes due to intervention by the local elite:

1. In traditional communities, the villagers and their leaders may feel threatened by
th potential disruption of existing socioeconomic hierarchies due to development
projects. Participatory approaches also conflict with traditional patterns of
authority and status. Hence the traditional elites may resist its introduction, or
redistributive pressures deleterious to project efficiency.

21
 2. Meanwhile in societies where markets are well entrenched and elites dominate
both economically and politically, project benefits become prone to elite capture.
For example, cost-sharing arrangement are common to many projects, which the
elite can easily shoulder to project design and beneficiary selection towards their
own preferences. Organizational efforts incur transaction cost which are charged
to community members; often it is only the members of the elite that can bear
these costs. This jibes with Michener’s (1998) observation that “participation” in
practice entails the active work of only a few community residents, typically in
leadership positions.

3. Local elite can assume the role of community benefactors, partly due to their
extensive networks with government officials and funding agencies. In so doing
they are able to deflect participatory processes away from their original
objectives. NGOs are organized for the most cynical purposes reasons, e.g. fund
raising, diversion, and employment of downsized bureaucrats.

For these reasons, Abrahams and Platteau argue against a rapid rollout program based on
massive donor financing of a participation-based strategy. Authentic participatory
processes require considerable investments of time and effort, which should be factored
in when designing community projects.

Implications for policy

Theory and evidence in favor of public support for CBAs is ambiguous. The strongest
case can be made for CBAs in the provision of local public goods, such as irrigation; the
case becomes progressively weaker in the areas of financial intermediation and especially
in agribusiness activities. For these gray areas therefore, the best recommendation
appears to be a targeted strategy of promoting CBAs. The credit review suggests an
adherence to microfinance principles, including group lending; in the absence of evidence
to the contrary, small groups should be preferred over large groups, which implies de-
emphasizing cooperatives as conduits of finance. Support for trade and processing
cooperatives should be selective of underdeveloped areas, where markets are fragmented
and perfect competition unlikely to be approximated. Needless to say, any financial
support should comply with minimum standards, such as studies of feasibility, allowance
for risk (especially risk that is covariate across farmers), etc.

The most significant policy stance towards CBAs, and cooperatives in particular, are the
list of tax exemption privileges. These privileges are non-targeted and non-selective, and
may therefore seem to be a candidate for phasing out. One must however be cautious of
making these adjustments, in view of probable strong resistance from farmer
organizations and their lobbyists. Priorities in term of subsidy phaseout should also be
kept in mind: the financial burden of fiscal incentives for export-oriented industries
probably dwarf by an order of magnitude the implicit subsidy to the cooperative sector;
hence, the any review of subsidy policy should take up this sector last.

22
6. Concluding Remarks

This survey began by noting the need for a rigorous framework of analyzing CBAs, as
well as a compilation of available facts about the contribution of CBAs to community
development. The review finds that the shift from centralized participatory and
community-based strategies, far from being a mere fad, has a solid conceptual and
empirical basis.

An obvious efficiency argument for CBAs is the provision of local public goods.
However even for commercial activities, CBAs may be beneficial in the presence of
market failures associated with imperfect competition, asymmetric information, and
imperfect contract enforcement. Joint liability lending and the cooperative form may arise
in response to these failures.

A solid factual basis is being laid for the development role of CBAs. The evidence
though seems weakest for agribusiness activities such as trade and processing, as it
cannot be clearly proven that a CBA counterpart of a private sector firm performs as
efficiently. The evidence grows progressively stronger for activities in which private
sector supply faces serious gaps (such as rural finance), and is most convincing for the
case of local public goods such as irrigation.

These provide the groundwork for building a policy framework regarding the promotion
of CBAs. While this study cannot prescribe the specifics of that framework, minimal
elements can be spelled out as follows: First, public support should be sensitive to the
every-present possibility of breakdowns in cooperation, participation, and governance.
Engaging community members in participatory processes should therefore not be taken
for granted. Second, support should not be extended in a blanket manner, but should be
selective and targeted to cases in which neither market nor command-and-control
mechanisms are deemed workable. Precisely what and where these cases are, should be
the object of further research in this important and exciting field of institutional analysis.

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